Why Bonds Matter in Investing
Stocks usually dominate investing conversations, but bonds deserve a place in almost every portfolio. Unlike stocks, which can fluctuate significantly from year to year, bonds offer a steady and predictable return. They are designed to smooth out the ride, reduce volatility, and give investors confidence to stay invested during market downturns.
For retirees, bonds can serve as a reliable source of income. For those still building wealth, bonds can prevent overreactions when the stock market turns ugly. Their role is less about growth and more about balance.
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Understanding Bonds
At its core, a bond is a loan. When you buy a bond, you are lending money to the issuer — typically a government or a corporation. In exchange, the issuer promises two things:
They will pay you regular interest, known as the coupon, for the life of the bond.
They will return the principal (your original investment) when the bond reaches its maturity date.
For example, if you buy a $5,000 Government of Canada bond with a 3% coupon and a 5-year maturity, you will receive $150 in interest each year for five years. At the end of year five, you get your $5,000 back.
Key Concepts Every Investor Should Know
Coupon: The fixed annual payment you receive, expressed as a percentage of the bond’s face value.
Yield: The actual return you earn, which depends on the price you paid for the bond and the coupon payments you receive.
Maturity: The date when the issuer returns your principal. Bonds can range from very short-term (less than a year) to long-term (30 years or more).
Credit rating: A score that reflects the issuer’s ability to pay you back. Government of Canada bonds carry the highest rating, while lower-rated corporate bonds pay more interest to compensate for higher risk.
Types of Bonds in Canada
Government of Canada bonds are the safest and form the backbone of Canada’s fixed-income market.
Provincial bonds carry slightly higher risk and therefore offer a bit more yield.
Corporate bonds pay even more but come with the risk that the company could default.
Strip bonds do not make annual coupon payments; instead, they are sold at a discount and pay the full face value at maturity.
Real Return Bonds (RRBs) are linked to inflation, so the value of your payments rises with the cost of living.
How Bonds Fit Into a Portfolio
The role of bonds changes as you move through your financial journey.
During your growth years, bonds usually play a minor role. Most investors focus on equities, which historically offer higher long-term returns.
As you approach financial independence, bonds can reduce portfolio volatility. This keeps you invested during market swings and helps you avoid panic selling.
In retirement, bonds provide income and, more importantly, protect you from the risk of selling stocks at a loss when you need cash.
Bonds also play a natural role in the bucket strategy for retirement: they often fill the short-term bucket (one to five years of spending), while stocks handle the long-term growth bucket.